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Fed statement propels Dow to record high close

Wall Street is the only place that people ride to in a Rolls Royce to get advice from those who take the subway. – Warren Buffett

The Dow Jones Industrial Average was the big winner last week among the major averages as it added almost 300 points to close at a new record high after the Federal Reserve reiterated its policy to keep interest rates low. The broader S&P 500 Index also posted a gain of over 1% and closed just below its all-time high. While many market pundits thought the Fed would change the language in its policy statement to reflect a more tightening bias, Fed Chair Janet Yellen instead used the exact same wording that she had used in the past to describe the Fed’s intentions. The statement calls for the bond-buying program known as quantitative easing to end in October and for interest rates to remain low for a “considerable time”, especially if inflation remains subdued and inflation expectations are within reason. The timing of the announcement could not have been better as earlier in the week the producer price index (PPI) was unchanged in August while the consumer price index (CPI) actually fell during the month and has increased only 1.7% over the last twelve months. With inflation well under control and running below its target rate, it’s no wonder that the Fed chose to keep the word “considerable” in its language. While Yellen also acknowledged that the job market is improving, she stressed that any changes in interest rates will be solely “data dependent”. In other words, the economy will dictate monetary policy. This is exactly how monetary policy should be conducted and what investors wanted to hear, as the Dow Jones Industrial Average will attest.

Last Week

While the FOMC meeting was the main attraction last week along with the inflation data, jobless claims also were a surprise as they fell by 36,000 to 280,000, a two-month low and at a level last seen before the recession began about six years ago. This confirms that the labor market continues to improve but housing market data remains inconsistent as U.S. housing starts dropped sharply, indicating that affordability may be a problem for potential buyers. Leading economic indicators also rose modestly and came in below expectations.

What was expected to be a close vote turned out to be fairly decisive as Scotland voted to remain part of the United Kingdom rather than secede and become independent. Alibaba Group Holding (BABA), a Chinese e-commerce company, became the largest initial public offering in history as it debuted on the New York Stock Exchange with a gain of almost 40%, making the company worth over $230 billion.

For the week, the Dow Jones Industrial Average climbed 1.7% to close at 17,279 while the S&P 500 Index rose 1.3% to close at 2,010. The Nasdaq Composite Index added 0.3% to close at 4,579.

This Week

After the much-anticipated Federal Reserve meeting last week, this week promises to be quiet in terms of economic data. Both existing and new home sales for August should show improvement over last month as the housing recovery attempts to get back on track. The final reading on second quarter GDP growth is expected to be revised upward to 4.6% from 4.2% and confirm a strengthening economy.

At least three regional Fed presidents are expected to give speeches about current monetary policy and the economic outlook, possibly affecting market sentiment. European Central Bank President Mario Draghi will meet with a European Parliament committee to review monetary policy.

Among the more notable companies on the earnings calendar this week are Autozone, CarMax, Nike Inc., Accenture, Bed Bath & Beyond and Carnival.

Portfolio Strategy

Although the Dow Jones Industrial Average ended last week at a record high, it has posted a gain of only 4.2% for the year. By contrast, the Dow Jones Transportation Average has been on fire as it has risen 17% so far in 2014 and has handily beat the performance of the S&P 500 Index, which is up 8.8%.  According to Dow Theory, reliable conclusions cannot be made about the trend of the stock market until it can be proven that the industrial average, consisting of 30 stocks, and the transportation average, consisting of 20 stocks, are either moving upward or downward at the same time. When this does happen, the averages are said to be confirming one another whether the direction is up or down. The fact that the Dow Jones Transportation Average has performed so well is considered a bullish sign for the major averages such as the Dow and the S&P 500 Index. Since the companies in the Transportation Average deliver the goods that are produced by other companies, the fact that this index is sharply outperforming bodes well for the other major averages. If Dow Theory holds true to form, then large capitalization stocks found in both the Dow and the S&P 500 should continue to do well.